Get With The Plan: October 13, 2013

Marc and Elaine have some big financial decisions to make.

Marc, 58, is on disability and living with cancer, which is currently in remission. Elaine, 55, wants to retire so she can be with Marc. They have a rental property in New York that they inherited, and they think it can help with their long-term finances.

“Should we sell our investment property from which we receive monthly rent of $3,740 but is worth $1.1 million?” Elaine asks.

The couple also has co-signed student loans for their three adult children — who still live at home — and they’d like to pay off the debt.

Elaine and Marc, whose names have changed, have saved $391,000 in IRAs, $48,900 in a brokerage account, $40,000 in a money market, $27,000 in savings and $12,000 in checking. Marc receives income from a pension and Social Security.

The Star-Ledger asked Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Fairfield, to guide the couple into the next step of their financial lives.

Lynch says if they have any concerns about having enough money for retirement, they should not pay off the student loans.

“You can get a loan for college but not to retire,” he says. “The reason why they give students loans are they are investments in the future. That college investment should pay dividends that can help them pay off the debt.”

Lynch says when children incur debt, they need to be responsible for it. Paying off a debt is never a pleasant thing, but after paying it off, they will never look at debt again as a positive thing and they will learn from that experience, he says.

Plus, no matter how solid their retirement plan, there is no perfect plan and they will never know exactly how much money they’ll need because no one knows exactly how long they will live.

“Once you give it away, asking for money back is generally not an option,” he says.

Lynch saw a lot of tax opportunities for the couple.

They’re in the 15 percent federal tax bracket, which means that they qualify for tax-free capital gains and qualified dividend income.

“They have the ability to get up to another $17,000 of income tax-free, and they are not taking advantage of this,” he says.

Also, because their income is lower than $100,000 a year, they have the ability to deduct “passive” losses, which is what real estate income qualifies as.

Now, the morbid topic: The couple must prepare for the event of Marc’s death.

When Marc took his pension, he selected the single-life option, which means that when he dies, the checks stop coming. His Social Security won’t last either, so if he dies, Elaine will lose more than $66,000 of income.

Marc did purchase additional life insurance with $630,000 in death benefits to help cover the eventual shortfall for Elaine, but two of the policies are term policies, and Lynch says there’s a chance they won’t be in place when Marc dies.

Lynch says it may be possible to continue his term coverage on a year-to-year basis.

“The coverage may be very expensive and generally the cost will increase each year, however, it may be worth it,” he says. “Since he just had cancer, he is ‘uninsurable’ and would not qualify for coverage anywhere else.”

Another insurance option could be for them to sell the policies if they can’t afford to keep them in place.

“Life insurance is an asset class where if you keep it in force, it will pay out a benefit at some time,” he says. “Companies will give you a check for the right to that death benefit as they know that they will get paid at some point. The sicker an individual is, the higher percentage of the death benefit they will get paid up front, which can help them with some of their cash needs today.”

Or, the children could pay the cost of the insurance, and when the death benefit is paid, they’d have enough to pay off the student loans.

Lynch calls this moment a learning point about pensions.

“The reason why there is such a dollar difference between a man’s single-life option and a joint-and-survivor pension benefit is because your wife will generally outlive you by about five years and you really do not want to take that bet,” he says.

If you are going to take a single-life payout, he says you need to make sure that you have permanent life insurance to make sure you can guarantee that your spouse is taken care of. Generally, he says, term insurance is not a good option for this because you don’t know for sure it will be there when you need it.

Given all this, there’s a big tax planning opportunity from the inherited home.

When they inherited the home, it was worth $700,000, and it’s now worth $1.1 million. That’s a gain of $400,000.

“If they sell that property, they would pay capital gains of $400,000, plus they need to pay recaptured depreciation on the depreciation allowance they took while renting out the property,” he says. “So between state and federal taxes, they could be looking at a tax bill of $150,000.”

If they plan correctly, though, they can make that tax bill never appear if they put the home in Marc’s name alone.

“There is a step-up of basis at death, meaning that if the value of the rental property is $1.1 million and they pass away, the new cost basis for the new owner is $1.1 million and they owe no income tax,” he says. “The tax savings just on this investment property would be enough to pay all the money owed on student loans.”